[Martin Wolf is] reacting to Cameron’s statement, semi-withdrawn but not really, that what Britain needs is for everyone to pay down debt, said in obvious obliviousness to the fact that if everyone cuts spending at the same time, income must fall.

But then, this kind of obliviousness is very widespread, and my experience is that if you try to point out the problem — if you try to explain that my spending is your income and vice versa — you get a belligerent response. Y=E is seen as a political statement, which in a way it is if one side of the political spectrum insists on believing things that can’t be true.

Krugman seems to be saying (though again, he’s a slippery fish) that if everyone pays down debt, then total spending must fall. Do people agree with me that that is not necessarily true, or is that indeed the (stronger) claim?

Let me restate my question in different words: I agree that if everyone reduces spending, then (nominal) income has to go down. However, Krugman above leads us to believe (without actually saying it), that if everyone tries to pay down debts, then we get a drop in spending (and hence a drop in nominal income). So is that part of what he considers to be an accounting tautology too? I.e. just how “stupid” does Cameron have to be here? Is he really ignoring accounting, or is Krugman conveniently slipping in an empirical assumption or a tenet of Keynesian models, that Cameron need not endorse?

38 Responses to “Krugman Accounting Bask”

I don’t know if I can resolve your confusion, but I was thinking something similar when I saw that post (and almost made a Silas-grade sarcastic reply). Taken seriously, Krugman’s claim would mean that it’s impossible for total private debt to decrease. Yet obviously, that has happened.

If nothing else, the creditors getting the repayments and pre-payments will go out and spend the money (or further deleverage, or hedge against another liquidity crunch, or whatever). There’s nothing fundamentally impossible or destructive about everyone waking up one day and saying, “you know … I don’t like being debt to others … too much risk of a liquidity crunch when I need to refi. Let’s not feed these lenders anymore.”

In fact, that would probably be a tremendous boon to the economy — in the sense we care about it.

Silas, right, for sure there’s nothing in principle stopping creditors from spending what the debtors are paying (in principal reduction). So there’s no problem (in principle) if we move to a society where debtors have lower levels of debt.

However, it’s possible Krugman has in mind that in that scenario, the creditors are engaged in “dissaving,” i.e. their indebtedness increases, say from -$100,000 to -$90,000.

I even have a response to that, but I’m asking our Keynesian colleagues to spell out exactly what Krugman has in mind here.

I suppose that one can also pay down debt from cash balances, but that would not reduce net indebtedness which was what I assumed was meant here. I’m missing how an individual can reduce net indebtedness without reducing spending and hence if ‘everyone” did it (and all the creditors are outside the system being discussed) net spending would have to fall.. Can you clarify?

I suppose it is possible that what is meant is not “net indebtedness” but simply average level of debt (ie excluding cash balances and outstanding lending balances) . In this case then I suppose everyone could pay down their debt without affecting AD at all in theory and then Krugman’s conclusions would indeed rest on some assumptions on the consequences of additional savings by the recipients of the increased debt payments.

Suppose a corporation wants to raise $1 million to build a new factory. One option is to issue bonds and take on more debt. But there is a second way. I’d be surprised if a Nobel laureate (and every other Keynesian I’ve heard comment on this issue) didn’t realize that, but such appears to be our situation. Yet I want to make sure I’m not missing something before going out on a limb in an article.

Dave the Debtor originally owes $1,000 to Chris the Creditor. Out of his normal paycheck, Dave cuts his usual consumption spending by $1,000 and uses it to pay off his debt to Chris.

Chris doesn’t want to increase his own consumption spending by $1,000 though, because then he’d be dissaving and he wants to maintain his financial assets. He no longer owns the $1,000 IOU from Dave, so Chris needs to acquire another $1,000 in financial assets. A corporation issues new stock for $1,000, and Chris buys the new shares. Then the corporation uses the $1,000 to buy a new software package.

So total spending is unchanged; Dave consumes $1,000 less but the corporation invests $1,000 more. Yet total debt went down in the community: Dave’s debt went down $1,000, and Chris maintained his own financial assets. The corporation, it’s true, has more shareholders now than it did before, but equity is not the same thing as debt. The corporation isn’t leveraged.

So, the only way I can make sense of Krugman’s assertions is if he says one of the following:

(A) People aren’t allowed to spend more on investment out of extra saving, because hey we’re in a liquidity trap.

or

(B) Sure I know some people make a big deal about debt versus equity, but we can’t get anal like that when I make claims about people paying off “debt” and the necessary impact on income.

Thanks for that example, Bob. That is pretty much how I was looking at it, as well. But, another thing that entered my mind is the fact that a debt is typically a representation of past spending and/or investment. You borrow money to either spend it or invest it. So, really, over the longer term there is no real change in spending by paying off a debt.

Another thing is that in order for a person to pay off a debt he must have the money to do so. Assuming that the money didn’t just grow on a tree in his yard, someone must have had to have spent the money in order for that person to have received it (to pay off the debt).

Krugman clearly doesn’t recognize that borrowers paying back principle and interest to lenders is an income. From the perspective of the aggregate economy, it is merely a transfer of who has control over money for spending. He doesn’t seem to understand that paying back debt is just a transfer of money available for spending from some people (borrowers) to other people (lenders). It won’t reduce incomes, it will just change who earns income and who spends out of that income.

Can we all finally agree that Krugman is really just a vulgar Keynesian who actually believes that if people do anything other than consume with their money, that nominal incomes must fall, because consumption spending is the only “true” spending that generates income?

I bet if someone asked Krugman what would happen if everyone started to take a part of their earnings, and then hired all the currently unemployed people, thus eliminating unemployment, Krugman would respond by saying that this will cause a drop in incomes and thus increase unemployment. So when people get hired, they’re not really getting hired!

You see, if employers were to eliminate unemployment by hiring more workers, the employers would not be consuming with that money, they would be paying wages. Got that? If we want to solve unemployment, the solution is that people should reduce the payment of wages, and instead spend all their money on consumption. Incomes and employment would skyrocket! Just spend spend spend and the jobs will come! Where? Don’t know! Not my problem!

It’s posts like these that truly expose just how warped Krugman’s worldview really is.

OK so Mammoth, you are saying if everybody tries to pay down debt, then as a matter of accounting total spending will fall? (I think that’s wrong, but I want to be sure you are making the claim before I accuse you of a mistake.)

But for a debtor to repay his debt increasing his net savings, then someone else must match his net savings by taking on an equal amount of debt, or run down his savings. Otherwise nominal income will fall.

In other words, someone’s surplus must be matched by an equal deficit from the others, or nominal income will fall.

Tel showed it some time ago with his example of the young and the old farmers, although he believed he was proving the opposite.

But for a debtor to repay his debt increasing his net savings, then someone else must match his net savings by taking on an equal amount of debt, or run down his savings. Otherwise nominal income will fall.

In other words, someone’s surplus must be matched by an equal deficit from the others, or nominal income will fall.

False. If a debtor were to reduce their consumption spending, and pay down their debt instead, then there would be no difference in nominal incomes at all. The fall in consumption spending and hence income of those selling consumer’s goods, will be matched by an equivalent increase in debt repayment and hence income of those creditors who are being paid back.

Total nominal incomes are unchanged.

Tel’s point is that there is no need for a government or central bank to add to the private sector’s cash balances, i.e. “net savings”, to facilitate an increase in credit/debt, and there is no need for a government or central bank to subtract from the private sector’s cash balances, i.e. “net savings”, to facilitate a decrease in private credit/debt.

Credit and debt are individual contracts. They can arise and they can be paid back without a single change to the supply of currency in the private sector.

So let’s see: John owes Jack a bunch of money but John has no job so he can’t pay in cash. John offers to build Jack an extension to his house by way of repayment, and Jack accepts.

Now the debt is paid back (so John is better off) and Jack has a valuable asset (so Jack is better off) and Jack can choose to sell the house at a future time (i.e. Jack has equity which is directly equivalent to savings).

Oh yeah, but MMT doesn’t recognize assets, not does it recognize prices, stocks, nor anything real. Have you tried waking up? Lots of interesting stuff out there to see, but you would need to open your eyes a bit if you want to see it.

You keep missing Tel’s point because you refuse to think outside the MMT box. Tel’s example is that the debt can be eliminated through means other than money payment. It can be paid back through production and labor.

I hate to even give the slightest hint that I might be taking Krugman’s side on this matter (or any matter) but he answered the question a year ago, it does sound a little bit like he has a point here:

The answer is that on average, debtors are more likely to be constrained by their balance sheets than creditors.

Tel, I think you’re probably right that the link represents the kind of thing Krugman is thinking in writing the post, but it wasn’t what he actually said in his criticism of Cameron. He appears to have fallen into his usual trap of over reaching out of his tribalist conviction that ‘they’ are not just wrong but stupid and evil. It just doesn’t quite scratch the itch to make the empirical argument that total income might fall, he had to depict Cameron as such an idiot that he cant even grasp things which are true by definition.

Bingo Teqzilla. Tel, do you get what Teqzilla is saying? Krugman can ultimately retreat to, “We’re in a liquidity trap right now, Murphy are you nuts what kind of corporation is going to issue new stock to build a factory?” But then he could no longer say, “Cameron doesn’t understand accounting.” Instead he would have to say, “Cameron rejects Keynesian economic models, just like a bunch of Nobel laureates whom I also claim are morons.” Doesn’t have quite the same sting.

I accept that if you give the benefit of the doubt to Krugman, in as much as there are unwritten implications that go beyond the simple accounting balance (although to be fair Krugman had already explained his position previously) then you should also give Cameron the benefit of the doubt that maybe his message goes beyond the most simplistic interpretation.

But having said that, Cameron did a poor job of explaining his position, and he changed his position mid-stream, so it isn’t clear what exactly his position is.

In case you can’t tell I don’t believe Cameron stands for all that much.

I’m not sure if this applies, but say that instead of individuals loaning money to others, that banks are doing all the lending. So as the debtor pays off his debt, the money disappears just disappears. The bank made up the money when they loaned it, so when they get it back, the money supply contracts. That’s what I understand happens with bank loans at any rate.

If EVERYONE is doing that, then the banks can’t reloan that money even though they may have excess reserves, and so, spending slows down. Instead of staying in debt and buying another TV, the consumer pays off his debt and the money just gets obliterated in the fractional reserve system.

If everyone reduces consumption spending to pay down their debts, then that does tend to reduce the income of those selling consumer goods.

It is exactly the “paradox of thrift.”

The market process that prevents a decrease in nominal income in todal is a lower interest rate. This results in a decease in the quantity of saving supplied and an increase in the quantity of investment demanded.

This could involve different people borrowing more for consumption, or some those those who were paying down debts reevaluating what they were doing and not paying them down after all. And firms might borrowing to fund the investment, so that total debt debt doesn’t fall after all,

There are other possibilities–firms fund at least some of the investment with equity and some of those saving purchase the equity. And some of those who saving and lending more might do so at a slower rate. Some of those creditors who were dissaving anyway (say retired people) might do so faster.

And so, debt can go down without nominal income falling.

The implicit assumption of debt repayment leading to a reduction in expenditure is that those receiving debt repayment accumulate money and hold it. That isn’t impossible, and to some degree is reasonable, but it needs to be made explicit. Which is a problem with the simple “Keynesian” story of the paradox of thrift. What I find odd is that when we add debt, suddenly we find lots of anti-Keynesians adopting the view.

I agree that in the final analysis the reason why encouraging people to pay down debts now would be a bad idea for Krugman is that interest rates cannot fall under current conditions–the liquidty trap idea.

Of course, if Great Britain is counts as a small, open economy, much of the reduced expenditure would be imports, and the resulting decease in nominal income in the rest of the world would hardly have a large effect on British exports. Considering the analysis above, British debtors can pay down debts, while British creditors can purchase more foreign debt instead. You know, the British trade deficit shrinks.

Captain Freedom:

Interest is income to credtors, but the repayment of principle is not income. At first pass, it is a change in the form of assets held from loans to money balances. If the money is lent back out or some asset is purchaed, then the form of the assets changes again. If it is spend on consumer goods, then there is dissaving. That is, the individual spends more than income.